Thursday, February 2, 2012

Tax Policy Needs To Foster Economic Growth And Decrease The Defict

My comment to "Will tax hikes hurt economic growth?" by Mark Thoma on CBS Money Watch:
As often happens in discussions about tax increases, the debates ambiguously interchange tax rate with tax revenue increases. If the issue is reducing the deficit, then along with spending reductions, tax revenue increases must occur. Tax rate changes, up or down, without a tax revenue increase will not produce more government funds. Since avoidance of government program or subsidy cuts are often mentioned side by side with tax rate increases, there are also issues of consumer welfare and how tax policy affects the nation's, or sub-population group's, well-being.

If effective tax rates are increased, taxpayers will undertake mitigating tax effects to reduce their taxes, e.g. buy more municipal bonds, delay sales producing capital gains, work less, delay investment, switch to more tax favorable investment categories, etc.

The economy and individuals will react to tax law changes and the amount of revenue from tax law changes has a degree of uncertainty. Behavior will change. The uncertainty is whether the behavioral change will offset the tax increase completely or only partially. Depending on the tax change and individual economic behavior, total revenue may go up, go up by less than projected, decline or remain the same.

Add to the debate that governments often spend increased tax revenue on programs, benefits and subsidies, which have their own negative and positive economic effects on employment, economic growth and future tax revenues. Additionally, consumer welfare changes are usually not modeled as part of tax law changes.

CBO uses JCT (joint committee on taxation) numbers for the amount of expected tax revenue from a proposed tax law change. Unfortunately, JCT models for tax law changes, while they assume some tax reducing behavioral responses, assume that taxes do not affect the overall growth of the US economy. JCT assumes away any economic growth affects from tax changes. In other words, Congress takes a blind eye that its tax law changes may affect the economy.

If the economy grows, there will be more tax revenue even if there is no change to tax rates, i.e. rates are not increased or lowered.

If tax rates are increased, individual and government behavior will change that will affect the economy. The economy could grow, grow less than if there were no tax changes, or decline. Tax revenue may increase, remain static or decline depending on the amount of economic and behavioral affects and the amount of change in tax rates.

The issue of tax law changes is more important now than it has been in a long time. US economic output is well below its long-term trend. The gap between the potential US economy and the current economy is enormous, as measured by total GDP, GDP per capita, workforce participation rates, and employment levels.

While the US current and projected deficit is a concern, so is the US economic output gap. Policies that can foster faster economic growth, increase employment and workforce participation must be part of any policies that bring the projected US deficit to manageable levels.

Additionally, there is the unstated the assumption that if tax reduction, or tax policy inaction, occurs, general welfare will decline due to program cuts. While program cuts and benefit decreases may occur, it is a gigantic, illogical leap to assume that overall, or in any specific US population subgroup, general welfare will decline. Government legislated program mandates are often paternalistic with restrictions on eligibility and benefit use. They substitute government choices for individual participants' free choice. Program eligibility requirements have implicit high marginal tax rates, at the point where the benefit is lost. Along with benefit use restriction requirements, there is no certainty that a program participant's welfare is better with a government program that without.

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